Paving over Pension Liabilities

July 9, 2012

Private corporations are asking Congress to change how they calculate their annual pension contributions, which could create a huge unfunded liability for taxpayers, say Jason J. Fichtner and Eileen Norcross, senior research fellows with the Mercatus Center.

The law requires corporate plans to measure their liabilities, and determine annual contributions to fund them, using the rate of return on corporate bonds -- the discount rate. Now, corporations are lobbying for Congress to allow them to increase the discount rate. This allows accountants to assume better investment performance, setting aside fewer dollars for future pension obligations.

The provision in the Senate-passed version of the transportation bill currently under consideration in the House would allow corporations to use a 25 year average rate as opposed to the current 2 year average.

This would increase the current discount rate from the 4 percent range to roughly 6 percent.

Since liabilities are sensitive to discount rate assumptions, the plan's liability will change roughly 15 percent for every one percentage point change in the discount rate.

For example, Boeing reports that a mere quarter of a point increase in the discount rate could cut its pension liability by $1.7 billion.

An arbitrary increase in the permitted discount rate essentially amounts to the government granting corporations permission to underfund their pension savings. The current position of the nation's state and local governments, which have been underfunding for years, demonstrates why this is a bad idea.

States across the country are facing the consequences of inaccurately accounting for their retirees' pension benefits by keeping their discount rates unrealistically high.

State and local pension plans face $4.5 trillion in unfunded employee retirement payments.

Stockton, California; Central Falls, Rhode Island; Pritchard, Alabama; and Vallejo, California, are just a few municipalities driven to bankruptcy by resultant spikes in pension payments.

Furthermore, allowing corporations to underfund would leave taxpayers on the line. Pension payments are guaranteed by the Pension Benefit Guaranty Corporation (PBGC), a federal agency that is paid for by tax dollars. When (not if) corporation's set-aside savings prove insufficient to meet obligations, it is the PBGC (and consequently, the taxpayer) who will be left with the bill.